Prediction Markets move into the forecasting mainstream

Prediction Markets move into the forecasting mainstream as a "specialists’ market [that] is smarter than the broader and more turbulence susceptible big markets," thereby "attracting significant event risk monitoring attention and that it will tend to reflect presumptions driving some of the ‘smart’ money at play in broader markets."

Speculation over Poindexter's departure spawned its own prediction market:

Ironically, the aftermath of the DARPA controversy provided a vivid illustration of the power of markets to provide information about probabilities of future events. An offshore betting exchange, Tradesports.com, listed a new security that would pay $100 if the head of DARPA, Admiral John Poindexter, was ousted by the end of August 2003. Early trading suggested a likelihood of resignation by the end of August of 40 percent, and price fluctuations reflected ongoing news developments. Around lunchtime on July 31, reports started citing credible Pentagon insiders who claimed knowledge of an impending resignation. Within minutes of this news first surfacing (and hours before it became widely known), the price spiked to around 80. These reports left the date of Poindexter’s proposed departure uncertain, which explains the remaining risk. As August dragged on, the price slowly fell back toward 50. On August 12, Poindexter then issued a letter of resignation suggesting that he would resign on August 29. On the 12th, the market rose sharply, closing at a price of 96.

INTRADE is functioning like a window into one of the better informed layers of a global commodity market where there are in effect tiered levels of insight into events that will drive global pricing. (Metal traders know more than screen traders, metal producers know most of all – especially in getting ahead of LME inventory relevant events.) We’ve seen political events play out in crude pricing, LA government policy affect sovereign credit spreads or Chinese tax changes affect metal pricing.

Wolfers and Zitzewitz describe this form of Prediction Market as:

markets where participants trade in contracts whose payoff depends on unknown future events. Much of the enthusiasm for prediction markets derives from the efficient markets hypothesis. In a truly efficient prediction market, the market price will be the best predictor of the event, and no combination of available polls or other information can be used to improve on the market-generated forecasts. This statement does not require that all individuals in a market be rational, as long as the marginal trade in the market is motivated by rational traders. Of course, it is unlikely that prediction markets are literally efficient, but a number of successes in these markets, both with regard to public events like presidential elections and within firms, have generated substantial interest...

The basic forms of these relevant contracts will reveal the market’s expectation of a specific parameter: a probability, mean or median, respectively. But in addition, prediction markets can also be used to evaluate uncertainty about these expectations.

These probability, mean or median type contracts are differentiated:

Probability:"winner-takeall" contract, the contract costs some amount $p and pays off, say, $1 if and only if a specific event occurs, like a particular candidate winning an election. The price on a winner-take-all market represents the market’s expectation of the probability that an event will occur (assuming risk neutrality)...

Mean:"index" contract, the amount that the contract pays varies in a continuous way based on a number that rises or falls, like the percentage of the vote received by a candidate. The price for such a contract represents the mean value that the market assigns to the outcome...

Median:"spread" betting, traders differentiate themselves by bidding on the cutoff that determines whether an event occurs, like whether a candidate receives more than a certain percentage of the popular vote.

[The] application of expert insight capture to Mittal’s internal price planning, [which when combined with] internal web logs seems to me to be very interesting uses of IT to radically flatten senior management’s access to real in-house expertise that is otherwise usually out of reach. It is not necessarily high value insight but it is probably better to have it than forego it. It is probably not enough to satisfy a reputation risk objective, such as a Know Your [X] due diligence requirement.

how it can be spoofed so as to skew the results, thereby possibly influencing the pundits, who might then influence the electorate. If one is willing to 'lose money' on the trade, there is the possibility of gaining the 'greater good' of your candidate's victory. The first comment in the readers reply to Leonhardt's article speaks to the same idea.